Microsoft Plus Nokia - How Will Ecosystem Partners React?

How does the Nokia (NYSE:NOK) acquisition affect Microsoft's (NASDAQ:MSFT) ecosystem partners? An ecosystem has significant interdependencies as it relies on the network effect. As Microsoft put it in its acquisition-related presentation:

Devices help services and services help devices. Success in phones is important to success in tablets. Success in tablets will help PCs.

Phones are a high-volume item and therefore represent a very significant portion of the total number of endpoint devices in the ecosystem. In addition, smartphones have a central role among the different form factors as they represent mobility. Therefore, smartphones are a critical link in the Microsoft ecosystem.

Concentration of Risk in a Critical Link

As the ecosystem has interdependencies, the smartphone lineup has to be competitive for the entire ecosystem to reach its full potential. The competitiveness has been and will continue to improve with new generations of devices. However, the ecosystem also requires high certainty that each link will continue to exist and be competitive in the future.

Currently, Nokia is the only significant smartphone hardware partner in the ecosystem with over 80% market share. This represents a concentration of risk not only for Microsoft, but the whole ecosystem -- including other hardware partners. By acquiring Nokia's Devices and Services segment, Microsoft is eliminating the uncertainty of the whole ecosystem having to rely on Nokia -- a third party -- for providing the critical smartphone link. With the acquisition, Microsoft is taking greater control of the link.

At the same time, the acquisition demonstrates Microsoft's high level of commitment to its current strategy, which in turn enables other partners to commit. High level of commitment throughout the software and hardware ecosystem is important especially given the size and interdependencies of the ecosystem.

As for other stakeholders, Florian Mueller of the FOSS patents blog writes:

There can be no doubt that today's deal is one of the most pro-competitive M&A deals in the history of the information and communications technology industry: Consumers, wireless carriers, app developers and other stakeholders don't want the smartphone business to become a duopoly.

Microsoft's Vertical Integration as a Threat to partners

Microsoft is integrating vertically, which is demonstrated by the Surface products and now the acquisition of Nokia's device segment. Vertical integration is a threat to some of Microsoft's hardware partners. However, there are some mitigating factors regarding the Nokia acquisition:

Microsoft's third-party PC and tablet partners don't currently derive significant revenue from selling smartphones within the ecosystem. In other words, smartphones don't directly compete with the hardware products that Microsoft's partners are selling within the ecosystem.

Apart from Nokia, the few smartphone partners like HTC (OTC:HTCKF) and Samsung (OTC:SSNLF) have so far demonstrated a lack of commitment to the Windows Phone platform. The acquisition could negatively affect the potential future commitment of HTC and Samsung. Nokia is already enjoying the cost advantages related to the Strategic Partnership agreement with Microsoft. In a sense, this advantage will continue as Nokia's phones become part of Microsoft.

In addition to smartphones, Nokia is also about to expand into tablets, which could be seen as a threat to other partners making Windows tablets. However, Microsoft already has the Surface lineup and therefore Nokia's future tablets don't change the competitive dynamics within the ecosystem that much.

Conclusion

Overall, the ecosystem has eliminated a concentration of risk in a key area. The hardware-related acquisition is not a major competitive threat to most of the current hardware ecosystem partners. On the contrary, it further enables the most important partners to commit to the ecosystem.

Disclosure: I am long MSFT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.